One-way bet on house prices as the flood of easy money dries up

Wednesday 27 February 2008 08:21 BST

According to Stenham Consultants, an adviser to property buyers, the main reason commercial property prices went up so much in the last three years was there was simply too much money around and it was too easy to borrow. Now the money is drying up, prices are falling fast.

If this is true of commercial property - and the facts support the assertion - how much more true might it be for residential?

Nationwide, the largest building society, accounting for about one in 12 UK house mortgages, announced this week that it is to impose tougher conditions on its loans. In particular, from now on it will lend a smaller proportion of a property's total value.

Overnight, this meant that people seeking to buy a £150,000 home who would last week have had to put down £15,000 would nowhave to find £30,000 of their own money as a deposit. If they wanted the same interest rate as was available last week, they would have to stump up £37,500.

Nationwide is by no means alone. For obvious reasons, Northern Rock has stopped lending - in stark contrast to this time last year, when it provided one in four of all new mortgages. Elsewhere Abbey, Alliance & Leicester and no doubt most of the others are drawing in their horns. Even before these public declarations of caution, the monthly statistics for the number of new mortgages were showing sharp falls.

The point for homeowners, and buyers and sellers alike, is that money drives the market. This rationing of home loans means house prices must fall, because at current prices no one has the money to buy them.

Interestingly, this self-evident observation chimes in with a detailed analysis produced a couple of weeks ago by Rolf Elgeti, former head of research at ABN Amro, who now has his own firm Elgeti Ashdown Advisers. He found from looking at US house-price data that a 7% increase in the loan-to-purchase price ratio for first-time buyers led in effect to a doubling of house prices relative to household income.

It does, of course, take time for these relationships to work through the system, but there is no mistaking the eventual impact. And just as extra finance pushes prices up, reduced finance will bring them down.

More evidence from the real world comes in yesterday's figures from Persimmon, our biggest housebuilder. It said that reservations for new homes were down 19% on a year ago, the number of people visiting its sites had fallen 13% and cancellations were up 20%.

None of this means prices are falling, but it does indicate a significant drop in demand. The builders are cutting back to reduce supply and to soften the impact of the new market conditions. But they can do nothing about the second-hand market, where most transactions take place. House prices this year are only going one way.

THERE are some of us who have always thought the main purpose of the drive to improve corporate governance was not to improve company performance, but to help fund managers avoid the embarrassment of investing in companies that went bust.

Policy was skewed towards risk control rather growth. Equities were required to behave like bonds but still deliver excess returns. Time moves on, however, and the Association of British Insurers today published research that can legitimately claim to indicate a link between good governance and good performance, and show that bad governance leads to underperformance.

For the purposes of the study, bad governance was equated with a company receiving a red-top alert - a warning from the ABI to its members that it was seriously in breach of some core principle or other. It turns out that about half the red-tops were provoked by disputes over pay (with board composition being the other big issue). But, the ABI argues, probably correctly, pay is often a symptom of wider failings.

The key finding was that when the companies were compared with their peers and the market as a whole over the next few years, they did relatively badly - poor performance being defined by a lower return on assets as well as a dismal share price.

Overall, the research delivers three new insights. First, the volatility of well-governed companies is lower, meaning the share price does not crash around so much. Second, the link between good or bad performance takes a while to come through. ABI flagged Northern Rock, for example, as a worry for several years before it finally went pear-shaped. Third, if a company has good governance, its performance can be expected to improve further over time.

Taken as a whole, the conclusion seems inescapable. Despite scepticism from people like me, good governance make a difference.